Equity income funds are some of the most popular with our clients. It’s hardly a surprise considering the miserly interest rates being offered by many high street banks. Most funds in this sector aim to generate a rising income, as well as increase the value of your original investment over the long term. The income can be paid out to you as cash, or reinvested in the fund to boost long-term growth.
Different fund managers take different approaches to income investing. Some focus on larger companies that are seen to be more stable and have paid regular dividends for many years. Others invest in higher-risk small and medium-sized companies. These might pay a lower income to start with, but have more dividend growth potential.
We like the simple idea behind equity income investing.
Investing in a dividend-paying company means your wealth grows with the company’s. You're entitled to receive a share of any profits paid out as dividends. The best companies will grow their profits and dividends.
Not all companies’ profits – and therefore their dividends – are sustainable though. This is why we like equity income funds. An expert fund manager invests in a range of companies reducing the impact if one gets into trouble. It’s less risky and more convenient than trying to choose individual shares yourself.
Interest rates are close to historic lows. And they're unlikely to rise significantly in the short term. This makes the prospect of regular dividends from some of the UK's most successful companies attractive.
Dividends are clearly important for income investors. But they're just as important for those who want to grow their investment. If you don't need the income now, you can reinvest the dividends to buy more shares. This can mean you get even more dividends in future. Repeating this process over a long period is a tried-and-tested way to grow your wealth, though there are no guarantees.
We think equity income funds can provide the foundation of almost any investment portfolio. Keeping cash aside for a rainy day is important but an income fund could be considered for savings that aren't needed in the short term. Reinvesting dividends when you don’t need the income could potentially help your pot grow at a faster rate. However, investments and their income don’t offer the same security as cash, and will go up and down in value, so you could get back less than you invest.
Please remember past performance is not a guide to future returns. Where no data is shown, figures are not available. This information is provided to help you choose your own investments, remember they can fall as well as rise in value so you may not get back the original amount invested.
The UK Equity Income sector made some decent gains over the past 12 months despite a nervy start. At the end of 2018 it fell with the rest of the UK stock market, but recovered well. It’s been a few steps behind the broader UK stock market throughout the year though.
Technology companies were the strongest performers in the UK recently. They tend to pay low-to-no dividends though. Healthcare and mining companies also did well. They are among the sectors favoured by income investors so helped the UK Equity Income sector’s returns.
Holding back the sector most were telecoms companies. On the whole oil & gas companies and banks either fell or made virtually no gains, so didn’t help either. Other dividend stalwarts such as financials, utilities and tobacco companies, also lagged the broader UK market.
Some investors have fallen out of love with the UK Equity Income sector due to disappointing returns compared to the broader UK and global stock markets in recent years. It’s true many of the most dependable sectors for income have become unpopular, partly due to ethical concerns for sectors such as oil & gas, mining and tobacco. Brexit worries have also held back returns, although it should be remembered the biggest dividend-payers in the UK make most of their money overseas.
We still think the sector can be an excellent way to grow your wealth over the long term though. Companies paying higher dividends have normally done better than lower-yielding ones, but there will be times when this isn’t the case.
In the past 10 years* the IA UK Equity Income sector returned 119.3% compared with the FTSE All-Share’s 120.4% gain. Remember past performance isn’t a guide to future returns.
10 year performance IA UK Equity Income vs FTSE All-Share
Past performance is not a guide to the future. Source: *Lipper IM to 30/11/2019.
Our favourite funds in the sector
Each of the funds below can take their charges from capital. This can increase the yield but reduce the potential for capital growth. All investments can fall as well as rise in value so you could get back less than you invest.
Source for performance figures: Financial Express
Siddarth Chand-Lall focuses on income opportunities among higher-risk small and medium-sized companies, which have more growth potential than bigger ones.
Having much of its portfolio invested in smaller companies makes this fund different to many others in the UK Equity Income sector. Medium-sized UK companies have performed better than the broader UK stock market recently, which has helped the fund perform better than the peer group average over the past 12 months. That’s not an indication of future returns. Many of the fund’s largest holdings performed well including investment company Intermediate Capital Group, self-storage REIT Safestore, and buy-to-let lender Paragon Banking Group.
We rate Chand-Lall highly and think he has the support of one of the UK's strongest smaller company investment teams. Most UK Equity Income funds gravitate towards the largest companies on the stock market, so this fund could be a good diversifier to an income-focused portfolio.
The fund blends high-quality dividend-paying companies with some unloved companies the manager thinks have the potential to recover and boost the fund’s gains.
Richard Colwell’s an experienced manager who, unlike many others in the equity income sector, only invests in UK companies. He’s bold enough to invest in unloved and unfashionable companies he thinks have good long-term potential.
The fund’s performed slightly better than the UK Equity Income peer group average, and slightly behind the broader UK stock market, over the past 12 months. That’s no guarantee of future performance. Investments in industrial companies did well, but utilities and telecoms held back returns a little.
We like Colwell’s sensible approach, doing the simple things well, and think this fund could provide a good foundation for an income portfolio.
The fund’s managers are disciplined in seeking out companies they think can grow their cash flow, as that’s what ultimately pays investors’ dividends.
Adrian Frost, Nick Shenton and Andy Marsh mainly invest in large UK companies, but they also invest in medium-sized and overseas companies if they think there’s an excellent opportunity. Frost is one of the most experienced managers in the UK Equity Income sector, and we think he’s built a talented team around him.
The fund’s been one of the strongest performers in the sector over the past 12 months, and has done better than FTSE All-Share too. Financial service companies were some of the strongest performers, including London Stock Exchange and Legal & General. Remember past returns aren’t a reliable guide to the future.
We think the managers’ combined skill, discipline and experience puts them in a strong position to keep delivering healthy income and long-term growth, but there are no guarantees.
Mark Wharrier’s managed this fund for just over a year now. Along with co-manager Mike Totton, he searches for overlooked companies he thinks have great potential.
The managers look for companies they think can grow their earnings faster than the market expects. They often find these among out-of-favour businesses they think have started to turn themselves around.
Wharrier and Totton focus on those paying an attractive income while they wait for the changes to take place. That can take time to happen though, so investing this way requires patience. They invest in a relatively small number of companies, which means each one can have a significant impact on performance, though it increases risk.
The fund’s fallen a fair distance behind the IA UK Equity Income sector’s returns recently. Its two largest holdings, oil giants BP and Shell, have both fallen over the past 12 months, holding back performance.
Carl Stick and Alan Dobbie look for companies that use their resources efficiently to produce attractive levels of cash.
The managers focus their efforts on what they think are under-appreciated businesses whose prospects are changing for the better. They usually invest in a relatively small number of companies. This means each one can make a big difference to returns but it’s a higher-risk approach. The managers can also invest in higher-risk smaller companies.
Stick and Dobbie think avoiding losses when markets fall is one of the best ways to make money over the long-term. That’s why they generally shun debt-laden businesses and what they think are expensive share prices.
The fund hasn’t quite kept up with the UK Equity Income sector average performance over the past 12 months. Stick and Dobbie’s long-term record is better and we think they’re good managers, but there are others we prefer in this sector.
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Please note the research updates are not personal recommendations to trade. If you are unsure of the suitability of an investment for your circumstances please seek advice. Remember all investments can fall as well as rise in value so investors could get back less than they invest.
Our expert research team provide regular updates on a wide range of funds.